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Buying or building a home is likely one of the biggest financial decisions you’ll make in your lifetime. For many, realizing the dream of a custom-built home seems out of reach. However, FHA loans make it possible for more borrowers to build a home that perfectly suits their needs.
An FHA loan is a government-backed mortgage insured by the Federal Housing Administration (FHA). These loans offer more flexible qualifying than conventional mortgages, meaning you may be able to get approved even if you have past credit issues, a low down payment, or a moderate income.
In this comprehensive guide, we’ll explain everything you need to know about using an FHA loan to build a home from the ground up.
What is an FHA Construction Loan?
An FHA construction loan lets you finance the building of a new home on land you already own or purchase It combines features of a short-term construction loan with a long-term permanent FHA mortgage
You’ll go through one closing and get one mortgage to cover the entire process, This saves you the hassle and fees of getting separate construction financing and a permanent mortgage
There are two types of FHA construction loans
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FHA Construction-to-Permanent: For building a new home from scratch.
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FHA 203(k) Rehab Loan: For renovating an existing home.
With the construction-to-permanent loan, the FHA will initially pay your builder installments as completing designated phases. Once the home is finished, the loan converts to a traditional 30-year fixed-rate mortgage.
The 203(k) loan allows you to finance purchase and renovations in one mortgage. The minimum repair amount is $5,000.
FHA Construction Loan Requirements
While FHA loans offer more flexible qualifying standards than conventional mortgages, you still must meet certain criteria to get approved for an FHA construction loan.
Here are the key eligibility requirements:
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Credit Score: Minimum 500 credit score required. But you’ll need at least 580 for the lowest 3.5% down payment.
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Down Payment: Options for 3.5% down with 580+ credit or 10% down with 500-579 credit.
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Debt-to-Income Ratio: Maximum 50% with compensating factors, otherwise 43% limit.
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Loan Amount: Borrow up to FHA limit for your county, typically $420,680 for most areas.
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Cash Reserves: Expect you’ll need 10-15% of the loan amount available in addition to your down payment.
In addition to meeting these standards, the land and builder you use must be FHA approved. The property will also require an FHA appraisal.
How to Get an FHA Construction Loan
If you meet the eligibility criteria, follow these general steps to get an FHA mortgage to build a home:
1. Find Land to Build On
Purchase a vacant lot, use land you already own, or buy land using separate financing to be paid off later.
2. Get Prequalified
Contact FHA lenders to get prequalified and confirm you meet credit, income, and down payment requirements.
3. Select a Licensed Builder
Make sure to use a builder approved to work with FHA construction loans. Get multiple bids.
4. Get Home Plans and Apply
Work with your builder to draw up home plans and apply for the construction loan once details are finalized.
5. Close on the Mortgage
After appraisal and underwriting, you’ll close on the construction loan before breaking ground.
6. Builder Receives Draws
As phases finish, your lender will release funds to the builder via pre-scheduled draw requests.
7. Convert to Permanent Loan
Once construction completes and home passes final inspection, loan converts to traditional 30-year fixed FHA mortgage.
Tip: Ask your lender about rate lock options to protect against increases during the building phase.
Pros and Cons of FHA Construction Loans
FHA construction loans offer several unique benefits, but also have some potential drawbacks to weigh.
Pros
- One loan/closing for the full process
- Low 3.5% down payment option
- More flexible credit and income requirements
- Great for first-time or low-income homebuyers
- 203(k) good for renovating existing homes
- FHA construction oversight ensures quality
Cons
- More stringent property requirements
- Must use certified builder
- Monthly mortgage insurance required
- Limited to FHA loan amounts in your county
- More complex process than conventional loans
While FHA construction loans are excellent options for eligible borrowers, make sure you understand the extra steps and requirements compared to alternatives.
Alternatives to FHA Construction Loans
If you don’t qualify for an FHA construction loan or want to consider other options, here are a few alternate financing methods to build a home:
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Conventional construction loans from banks and homebuilders – Two separate loans/closings
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VA construction loans – For eligible military buyers, no down payment required
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USDA construction loans – For moderate income buyers in rural areas, 100% financing
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Renovation loans – Fannie Mae HomeStyle or Freddie Mac CHOICE Renovation for renovating existing homes
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Owner-builder construction – If you act as contractor, build over time with personal savings or small loans
Research all programs available and discuss the pros and cons of each with a loan officer. This will help you identify the most fitting and cost-effective solution.
Finding the Best FHA Construction Loan Lender
Choosing the right lender is key to having a smooth FHA construction loan process. Here are some tips for picking the best FHA mortgage lender:
- Verify they are approved to offer FHA loans
- Ask about their specific construction loan experience
- Get details on their builder requirements and approvals
- Learn about their draw request and fund disbursement process
- Inquire about rate lock policies and permanent financing
- Compare interest rates and fees from multiple lenders
Searching online consumer review sites like LendingTree can help you find top-rated lenders with a strong history of offering FHA construction loans.
What to Expect with the FHA Construction Loan Process
While every lender will have their own specific procedures, here is an overview of what you can generally expect when getting an FHA construction mortgage:
Prequalification – Initial review of your credit, income, assets, and down payment funds to determine loan eligibility.
Selection of land and builder – Must meet FHA requirements and standards.
Home plans finalized – Work with your builder to design blueprints and create materials list.
Appraisal ordered – Lender will order FHA appraisal to ensure home plans meet guidelines.
Underwriting – Lender will verify all information and documentation to approve you for final loan amount.
Loan closing – You’ll sign final loan documents and construction contract at closing.
Groundbreaking – Once loan closes, construction will begin on your new home.
Draw disbursements – Builder paid in installments as each phase finishes per contract.
Construction completion – Expect frequent inspections from lender throughout the building process.
Convert to permanent – Within 60 days after final inspection, loan converts to traditional 30-year fixed FHA mortgage.
Be sure to communicate regularly with your lender and builder throughout the loan and construction process to avoid any surprises or delays.
Tips for Your FHA Construction Loan
Follow these tips to ensure your FHA-financed home building project goes as smoothly as possible:
- Get prequalified early and interview multiple builders
- Be conservative with costs – it’s easy to go over budget during construction
- Understand the construction phases and draw request schedule
- Add a rate lock agreement to protect against increases
- Get everything in writing – leave no detail unspecified
- Plan for contingency funds in case of cost overruns
- Perform frequent inspections to catch any issues right away
- Stay in close contact with lender throughout the entire construction period
With proper planning and research upfront, you can feel confident using an FHA loan to build your perfect custom home.
FAQs About FHA Construction Loans
What credit score do you need for an FHA construction loan?
At minimum 500 credit score is required, but you must make a larger 10% down payment with a score between 500-579. With 580+ credit, a 3.5% down payment is allowed.
How much down payment is needed?
Options for 3.5% down payment with a 580+ credit score and 10% down with a 500-579 score.
Do FHA construction loans require mortgage insurance?
Yes, you’ll pay an upfront mortgage insurance premium of 1.75% of the loan amount plus ongoing annual premiums between .45% – .85% of the mortgage amount.
What happens if construction goes over budget?
It’s smart
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How does a construction loan work? Construction loans aren’t like regular mortgages. They typically last for one year, during which time the lender releases payments, usually directly to your contractor. The lender enlists an inspector to evaluate the project at various stages, and releases more funds once everything checks out. Once construction is finished, the loan either converts to a traditional mortgage or the borrower obtains a mortgage to pay it off.
- FHA construction-to-permanent loan: An FHA construction-to-permanent loan finances the ground-up construction of a home — including the purchase of the land or lot — then converts to a regular FHA mortgage. This is also known as a one-time or single-close loan; you won’t have to pay closing costs for two separate loans.
- FHA 203(k) rehab loan: An FHA 203(k) loan finances the cost of buying an existing home plus renovations and repairs. There are two types of 203(k) loans: a standard 203(k) for renovations costing $35,000 or more; and a limited 203(k) for smaller-scale, less expensive projects. Either option allows you to obtain one loan to buy and fix up a home, instead of two loans.